6 things to know before starting a SIP

SIP or Systematic Investment Plans are one of the most popular ways of investing in mutual funds. However, most new investors are wary of mutual fund SIPs and a lot of seasoned investors too struggle to get their SIP strategy right. Therefore, before jumping on to choose the best mutual fund SIP for you, let’s first know what SIP really means.

What is SIP

A SIP or Systematic Investment Plan enables you to invest a fixed amount at regular intervals (monthly, quarterly or annually) in mutual fund schemes, which in turn invest in the markets. Being a flexible instrument, SIPs help us build long term wealth and instils the habit of saving even in the most undisciplined of us. The major benefit of investing in SIPs is the power of compounding, rupee cost averaging and compounding benefits.

How to Choose the Best SIP

Choosing the right mutual fund scheme for starting your SIP is very critical for your investment needs and therefore, you need to know the following 6 things before starting your SIP.

1. Investment Objective: Before starting your SIP in a fund, it is important to know what you are investing for. You need to ask yourself questions like 1) are you investing for the short term or the long term 2) what is your risk profile? Your investment horizon and risk profile will help in determining which type of fund will suit you.

• For instance, if you are investing for the short term and happy with moderate consistent returns debt funds might be suitable for you. However, if you are investing for the long equity funds can be suitable for you as it has the potential of generating the highest return comparable to other fund categories.

2. Fund type: As mutual funds are of various types, it is important to know which type is suitable for your risk appetite. Let’s take a quick look at the types of mutual funds:

• Equity Mutual Funds – Equity Funds are the most preferred choice for doing long term SIPs. The equity funds are further categorised into various types like, large cap funds, diversified equity funds, mid & small cap funds, Index Funds and sectoral and thematic funds. These funds are ideal if your risk profile is moderately high to high.
• Debt Funds – These funds can be further classified based on the investment tenure. For example – long term debt funds, short term funds, ultra short term funds and liquid funds. Depending upon how long you want to continue your SIP, you should choose an appropriate debt fund. These funds are suitable for conservative to moderate investors.
• Balanced Funds – These funds invests in both, equity and debt instruments. While the equity portion provides the return kicker the debt portion provides stability to the portfolio. This is suitable for investors with moderately high risk profile.
• ELSS Funds – SIP in ELSS funds can be started if you want to save taxes under Section 80C. ELSS Funds are essentially diversified equity funds and suitable if your risk profile is moderately high to high.

3. Fund performance & Returns: A comparison of historical performance of the scheme you are investing in tells you how strong or weak the fund was but you must also check whether the fund has a consistent track record of beating the category average returns and also that the scheme performance is comparable to its peers in the group.

4. Fund House: The fund management practice and the investment process followed by a funds house and the fund manager are very important aspects in the interest of the unit holders. Before investing, know more about the fund house, the fund manager’s track record and the scheme you intend to invest in. You should read the scheme information document (SID) and key information memorandum (KIM) to know about fund house’s investment approach, the scheme investment objective etc.

5. Entry and exit load of the scheme: Around 4 year back, The Securities and Exchange Board of India (SEBI) stopped fund houses from levying an entry loads on the schemes. Now, the only charge you might pay is when you are redeeming a fund before the exit load period. This is called the exit load. You should know the exit load of the scheme you are investing in. This information is available on the application form or KIM.

6. Scheme expense ratio: The scheme expense ratio comprises of management fee, brokerage charges and administrative costs etc. and charged annually. Schemes with higher assets under management (AUM) usually have lower expense ratios as you can see in the following example in case of equity funds –

On the first Rs. 100 Crores of the daily net assets – 2.50% p.a.

On the next Rs. 300 Crores of the daily net assets – 2.25% p.a.

On the next Rs. 300 Crores of the daily net assets – 2.00% p.a.

On the balance of the daily net assets – 1.75% p.a.

Therefore, if your selected scheme has a higher AUM it will charge you lesser expenses and thus increase the returns.

Conclusion – starting a SIP is easy but if you know the above 6 things you can choose a scheme fitting to your risk profile and investment objectives and thus make your SIP investment more meaningful.